April Market Review

April Market Review

In April, the long-expected effects of the Federal Reserve’s (the Fed’s) rapid interest rate-raising policy continued to materialize, although equities remained resilient. According to Larry Adam, Chief Investment Officer at Raymond James, “After nearly 500 basis points of tightening, cracks in the labor market and economy are starting to show. This combination of decelerating economic growth and lowering inflation suggests the Fed is near the end of its most aggressive tightening cycle in over 40 years.”

Given the major forces that are influencing the market, now is a good time to answer some important questions:

Q: What does the market expect the Fed to do next?
A: The interest rate-setting committee is expected to raise rates by approximately 0.25 percentage points in May, bringing it to 5.25%. The market anticipates a rate cut by the end of the year, but the expectation is that the Fed will maintain the rate.

Q: What’s happening with inflation?
A: Inflation has continued to decrease throughout April, as it has for the previous nine months. Inflation is currently at 5.0% on a year-over-year basis.

Q: Is a recession still anticipated?
A: The Fed expects a shallow recession to begin in the third quarter. Credit is tightening, the first quarter showed slow economic growth, and new hire rates are significantly lower than last year. Although certainly not painless, the Fed believes that a recession may be a remedy to the declining, but still stubbornly high, inflation rate.

Q: Is there a risk to more banks?
A: Some regional banks have experienced problems, thanks to the Fed’s interest rate policy, as depositors seek better returns from government-backed, short-term Treasury bills and other funds. First Republic Bank was purchased by JPMorgan in a deal brokered by the Federal Deposit Insurance Corporation on May 1, making it the third bank to fail in two months. While this will continue to be an area of concern, it is not expected to pose the threat level that was feared in March.

Q: Will the Fed cut interest rates if the economy falters?
A: This is a critical issue. To avoid the “stop and go” strategy that may have prolonged the inflation crisis of the 1970s, we believe the Fed will employ a “hike and hold” approach, but this does not appear to be the prevailing view in the market.

Let’s take a closer look at the major indices for the year so far and explore other areas of interest.

Historic Scale for Inversion

In April, the Treasury yield curve, which compares 10-year and 3-month notes, peaked at a -172 basis point inversion with short-term rates higher and intermediate- to long-term rates lower. This has created additional difficulties for small banks. For comparison, the curve inverted -64 basis points during its peak in the Great Recession. The current yield inversion has lasted for 184 days, approaching the duration of the inversion before the 2001 recession. It is still much shorter than the inversion before the Great Recession, however, which lasted for 337 days.

“X-Date” Approaching for Debt Limit

The Treasury’s ability to use “extraordinary measures” to pay the country’s debts is expected to hit its limit as early as June. In response, House Republicans have passed a legislative package that proposes suspending the debt limit until March 2024, or until the debt reaches $1.5 trillion, whichever comes first. This bill includes budget growth caps, spending cuts, the reversal of some key policies set by the Biden administration, and regulatory easing for energy producers. Although the bill is unlikely to pass in the Senate, it opens negotiations to prevent significant harm to the U.S. creditworthiness and economy if a deal is not reached.

Germany Goes Non-Nuclear

In April, Germany completed its plan to phase out nuclear power production by shutting down its last three nuclear power plants, which had been in operation for 60 years. This move coincided with Germany reducing its dependence on Russian natural gas, which was previously seen as a key geopolitical advantage for the Kremlin before Russia’s invasion of Ukraine.

Inflation Problem in the U.K.

The March consumer price data was released in April and confirmed that the inflation rate in the U.K. is significantly higher than that of Western Europe or the United States. This represents the largest gap between the U.K. and the U.S. since data began in its current format in 1989. The inflation rate in the U.K. has also proved to be “stickier” than in other countries. The tight labor market is not unique to the U.K., but the country’s situation may be due to the lingering effects of Brexit, causing migrant workers to return home, and the ongoing consequences of the COVID-19 pandemic.

The Bottom Line

The Fed has been attempting to reduce inflation by slowing down the economy, which was expected to cause a recession. However, the economy has been resilient, and wage growth and a tight labor market have prevented a recession from occurring so far. Recent data from April, however, suggests that the recession may arrive in the third quarter, as predicted. Despite slowing economic growth and layoffs, high wage growth has remained a bright spot. It can be easy to get lost in negative daily headlines, but as has been the case throughout the pandemic and post-pandemic period, your team at GDS Wealth Management will continue to focus on your goals and long-term future. We appreciate your continuing partnership and trust. Please do not hesitate to reach out if you have any questions about this market update, the market itself, or your financial plan.

Sincerely,